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Ed Rempel’s Picks for The Best Smith Manoeuvre Mortgage III





Ed Rempel has put together an article for us indicating his favorite Smith Manoeuvre Mortgage(s).  This is part 3 of a 3 part series. In case you missed the other articles, here is part 1 and part 2.  This final article of the series will help you decide whether or not to cancel your existing fixed mortgage to start the Smith Manoeuvre.

What should you do if you want to implement the SM, but your mortgage is not due now?

If you are just buying your home or your mortgage is due now, you can just go get the best SM mortgage and start. But what if it is not due? Some mortgage brokers would encourage you to always pay the penalty to refinance, citing the huge tax benefits you will get. However, you will get these benefits anyway if you wait, and you could pay significant penalties to get out of your existing mortgage. This may or may not really benefit you. It is worth doing the math.

Fortunately there are a few options:

  1. You might be able to convert your mortgage to an SM mortgage at your current institution without penalty. Some will and some won’t.
  2. You might benefit from paying the penalty to refinance your mortgage and roll in other debt. There is a benefit to starting the SM sooner and you could save on refinancing other debt, all of which may or may not justify paying a penalty. It is worth it to do the math.
  3. You could get a 2nd SM mortgage and simulate the SM as best you can until your mortgage is due.

Some general guidelines:

  1. Today, with interest rates having risen in the last several years, if your existing mortgage interest rate is much below today’s rates, getting a 2nd readvanceable mortgage is most likely the best choice. Why? Because creatively setting up a 2nd readvanceable mortgage can usually mean you can get most of the SM benefit now anyway, so why pay the penalty and higher interest rate?
  2. If you have more than 2 years left in your mortgage term and the rate is lower than today’s rates, it is better to pay the penalty and move even to a higher rate if you would otherwise not do the SM at all. However, getting a 2nd readvanceable and doing the best SM you can is usually the best option.
  3. If you have more than 2 years left in your mortgage term and the rate is NOT lower than today’s rates, in most cases it is better to pay the penalty and start the SM in full now.

The best SM mortgage, if you are stuck in a non-SM mortgage, depends on:

  1. Where is your existing mortgage (if it is not due) and when does it come due?
  2. How does your rate on your existing mortgage compare with today’s rates?
  3. How much is the penalty to get out of your existing mortgage?
  4. What is your marginal tax rate? (We can tell you if you tell us what your taxable income and your spouse’s taxable income are.)
  5. Do you have other debts at rates higher than your mortgage? What are they, how much do you owe, at what interest rates and how much are you paying on these debts now?

For example, the Parkers have a $400,000 home with a $200,000 mortgage at 5.2% for 4 more years and paying $500 bi-weekly. They owe $10,000 on a Visa at 19% and $10,000 on a credit line at prime +2% on which they are paying $600/month ($277 bi-weekly). They are in a 40% tax bracket. They can get a new readvanceable variable mortgage at prime -.6%.

Their existing bank will not convert their mortgage to readvanceable for no charge. Therefore, they have 2 options:

A. Pay the penalty to convert their mortgage to a readvanceable mortgage. They can roll in their $20,000 of other debt and then increase their mortgage payment by the amount they have been paying on this other debt, which would increase it to $777 bi-weekly. This could allow them to invest a lump sum of $100,000 plus $103 bi-weekly with the Smith Manoeuvre.

B. Keep their mortgage and add a 2nd readvanceable mortgage for $120,000. They will not be able to access their principal from their 1st mortgage payments, but they can still roll in the $20,000 of other debt and make it a fixed portion or their new readvanceable mortgage and pay the same $277 bi-weekly they pay on this amount now. With this option, they can still invest a lump sum of $97,500 with the Smith Manoeuvre (no bi-weekly amount).

The Parkers would pay a penalty of $2,600 plus $3,600 in the difference in mortgage interest rates for 4 years. The projected benefit including the tax refunds of investing $100,000 instead of $97,500, plus $103 bi-weekly with an 8% return would be $1,514 over 4 years. In total, they are $4,686 better off getting the 2nd readvanceable mortgage and doing as much SM as possible until their mortgage comes due.

Note that they would also save $6,400 over the 4 years by refinancing all their other debt into their mortgage, but they can do that either way – with a new 1st mortgage or by getting a 2nd readvanceable mortgage. Therefore, replacing the mortgage is better than not doing the SM at all, but getting the 2nd readvanceable is far better than either of the other options.

Some financial advisors or mortgage brokers would recommend breaking the mortgage anyway, saying that the tax refund of $2,500 each year is much more than the penalty. However, this is over simplistic and ignores all the other factors, such as the interest that is paid (in order to get the refund), a reasonable expected return on the investment & the tax-efficiency of the investment, and the interest rate difference between the old and new mortgage rates.

On the other hand, if the Parkers existing mortgage has a rate of 5.9% instead of 5.2%, then they will benefit by $564 taking into account all factors by breaking their mortgage now and paying the penalty. In that case, they should replace their mortgage now.

If you are not sure what to do with your existing non-SM mortgage, you can contact us with answers to the 10 questions in Part 2 about your situation and the 5 questions above about your existing mortgage, and we will do the math for you to figure out your best strategy. We call it the “Ed’s Mortgage Breaking Calculation”. It is actually a very complicated calculation.

If you would like us to do this calculation for you and you are a Million Dollar Journey reader serious about implementing the SM (either with us or by yourself), you can call or email us or FT leaving your name, email address and day phone number, and ask for “Ed’s Mortgage Breaking Calculation”. One of our financial advisors, Harvinder Arneja, will phone you (so leave your daytime phone #) within a week to tell you which of the 3 options is best for you, which SM mortgage is best for you and why, and then refer you to our contact to get that mortgage.

Again, another generous offer from Ed Rempel for MDJ readers.  So if you're thinking about starting the Smith Manoeuvre, but you're currently stuck in a fixed mortgage, call Ed Rempel to calculate if the penalties are worth it or not. 





29 Comments, Comment or Ping

  1. Ed, did you create a program or spreadsheet to do the calculations for you?

  2. One more time…

    If you have more than 2 years left in your mortgage term and the rate is lower than today’s rates, it is better to pay the penalty and move even to a higher rate if you would otherwise not do the SM at all.

    This can’t possibly be true unless you have a very small mortgage and lots of equity in the house or if the difference in interest rate is negligible ( less than 0.1 percent). For someone who has a larger mortgage (ie 50% of the house value or more for example), the increased interest rate on the non-deductible portion will not be covered by the tax rebate or the higher assumed rate of return from the equity investments.

    As far as the Parkers go, if I was their financial advisor I would be a lot more concerned about finding out why they have $10k of credit card debt and $10k on a unsecured LOC and doing something about that situation rather than trying to get them into a SM situation which they are clearly not ready for.

    One other note – I can’t dispute the assumed equity rate of return of 8% but it’s only a valid assumption over a long period of time. If you are doing some sort of calculation regarding investing (ie paying down your mortgage vs rrsp or analysing the SM over the long term) then 8% is as good a guess as any. However when analysing whether to break your mortgage it is completely useless since there is too much variability in equity returns in the short term. If you have say two years left on your mortgage – your equity return over that time period might be 8% or it might be 18% or it might be -8%. There is no way to know.

    Mike

  3. I have to agree with FP, 8% is a good number to use over the long term, but it doesn’t work so well in the near term, i.e., trying to decide if you should break your current mortgage. It amounts to the same as deciding whether to take out an investment loan with a one year time horizon.

  4. 4. Investing Newb

    To Ed,

    Could I do the SM on a rental property that I own? Or does it have to be done on my primary residence?

  5. 7. Ed Rempel

    Hi FT,

    We created a spreadsheet. It takes into account all the common factors to help us figure out whether or not it makes sense to break a mortgage. It does not take into account every possible situation, but we keep adding to it whenever some new situation comes up.

    Ed

  6. 8. Ed Rempel

    Hi FP,

    My reference there is between breaking the mortgage to do the SM or not doing the SM at all. The expected benefit of the SM can be significant.

    If your mortgage is due in 3 years, you can do the SM then and start with all the available equity in your home. However, what you lose by waiting is the amount that the investments would have grown and the tax refunds you would receive during those 3 years.

    If you have $100,000 of stagnant equity in your home now, or $50,000 and you pay quite a bit of principal with each mortgage payment, the projected SM benefit can easily be larger than a mortgage penalty plus somewhat of a higher interest rate.

    For example, if you borrow $100,000 at 6.25% and invest it at 8%, your projected profit is $1,750/year x 3 years = more than $5,000. Then if you are in a 33% tax bracket and your investments are tax-efficient, you should also get a tax refund of $2,000/year x 3 = $6,000. Now the total projected benefit can be about $11,000. Your mortgage penalty plus somewhat of a higher mortgage payment now are probably less than this.

    Of course, starting with a 2nd readvanceable mortgage now and keeping the credit line is probably best, but comparing starting now with not doing the SM for 3 years most often means starting now is better.

    Your other points are generally valid. If we get the feeling that the Parkers are just spenders and will just run up their credit card again, then it is questionable whether rolling this into their mortgage is really a good idea. But we run into many people regulary that are generally good with their money but accumulated a debt at some point for reasonable reasons that won’t just reoccur.

    For example, if their debt came from paying for a kid in university that they had not saved enough for, happened while on maternity leave or during a period of temporary unemployment, or any of many reasonable and nonreoccuring reasons we’ve seen, then we can make a huge difference by getting rid of their debt once and for all, plus starting them on a major investment program with the SM.

    Your comment about 8% being only a long term average makes perfect sense. However, we have to advise people on what is most likely the smartest decision. For example, if you would have a 70% chance of making money by starting the SM now vs. a 30% chance of not making enough over 3 years to cover the penalty, what would you do? What advice should we give?

    There is another less quanitfiable benefit. If someone waits for 3 years to start the SM, will they remember at that time? If you calculate the SM projected benefit over 40 years, it can be huge. Therefore, if our calculator reveals no clear advantage either way, we often recommend starting now anyway, unless we are quite sure the client will definitely start it anyway in a few years. We would hate to see someone wait now because of a $2,000 penalty and then end up never doing the SM at all and missing out on a 40-year projected benefit of say $500,000.

    Ed

  7. 9. Ed Rempel

    Hi Investing Newb,

    I take it that is just a bit before a Newby???

    The SM on a rental property is the same as on your own home. In both cases, we convert the available equity into a tax-deductible investment loan. Whether or not the original mortgage is tax deductible or not does not change anything.

    On your rental property, the mortgage interest is deductible against your rent, but you are still creating equity that is doing nothing as you pay down your rental mortgage. Using this equity effectively is just as beneficial as using stagnant equity in your home.

    Plus, if you have a rental and a home, you have the added benefit of being able to do the Cash Dam.

    Ed

  8. 10. Investing Newb

    So does that mean we will be doing a kind of “double-dip” by making the mortgage interest on the investment property as well as the interest on the SM investment tax deductable?

    Is the SM designed to be followed throughout the life of a mortgage or can someone get in and out when they need to?

  9. Ed – thanks for the response.

    Mike

  10. 12. Ed Rempel

    Hi Newb,

    It’s not double-dipping because you deduct different interest. You deduct the main mortgage interest against the rent and then interest from the credit line against with the SM.

    As for your other question, I guess both are correct. You can get in and out whenever you want, but it it not recommended. This is a strategy of borrowing to invest, which is theoretically more risky than just investing your own hard-earned money. The investment returns are more predictable long term. We would not advise it as a short term strategy.

    Why are you asking this? If you think you can market time by going in and out, I would not recommend that either. Studies show most market timers lose money and under-perform less active investors.

    If you are moving and may be without a mortgage for periods of time, there are alternatives that can allow you to keep your investments in between.

    Ed

  11. 13. Investing Newb

    Hi Ed,

    I won’t be trying to time the market. However, we are planning to move by spring of next year. I’m just not sure if we should start the SM now or after we move.

  12. 15. Ed Rempel

    Hi Newb,

    It’s hard to answer your question without knowing the details of your situation. The general answer, however, is that the SM properly implemented is a very effective long term strategy, but can be very risky short term.

    My suggestion would be to figure out how you would implement the SM on this home and then figure out how you would implement it on your new home. Whatever part can be done both times, do it now and then just transfer it to your new home.

    Most of the time, you can transfer the SM to your next home. Just make sure you set it up without fees and with an open SM mortgage.

    Ed

  13. 18. Cross the River

    Salutations,

    After reading numerous pages on numerous websites and analyzing my mortgage/financial situation, I’m considering the SM.

    But I still have 2 questions.

    1- Living in Quebec, is the SM still a good option (Interest deduction issue).
    1- Is the CIBC Home Power LOC any good for the SM?

    Thank you for the info.

  14. 19. Ed Rempel

    Hi Cross,

    I just noticed your post here. In answer to your questions:
    1. tthe SM still works fine in Quebec. You won’t get tax refunds, but if you invest tax-effiently anyway, I am almost positive that you can carry forward your interest deductions to claim them in future years. This essentially means you may never have to pay tax on the investment gains.
    2. The CIBC Home Power LOC does not work for the SM. It is just a credit line and does not allow a mortgage within the same product. CIBC is still the only one of the big 5 banks that does not have a readvanceable mortgage.

    Ed

  15. 21. Ahmet

    Hi Ed,

    If the Parkers get a 2nd readvanceable mortgage for $120K, at the initial phase will they have $320K of total mortgage, $120K of money (investment or not) and $0 of HELOC? If this is the case, since they did not get any investment loan (HELOC = $0), they cannot get any tax refund from $120K. Is this correct?

    In reverse if they get a HELOC of $120K and do not get the 2nd readvanceable mortgage, they can get tax refund from that investment. They can implement this strategy for 4 years until their original mortgage is due. Afterwards, they can start a new readvanceable mortgage and if possible (not sure) combine that existing HELOC with the readvanceable mortgage.

    Does it make sense?

    Thanks,
    Ahmet

  16. 22. Tyler

    Hi Ed,

    Do you have any experience with First Calgary? I just talked to a mortgage specialist and she said she can set up exactly like BMO ReadiLine with fully open at prime. And I can do all transaction online.

    Does anyone here has any experiences with First Calgary? Really appreciate any help.

    Thanks
    Tyler

  17. 23. Tyler

    Hi everyone,

    I called BMO mortgage specialist and she offers me Prime – .4 for 3 year open variable rate. I am in Calgary, anyone else has any better deal?

    Cheers
    Tyler

  18. 24. Cannon_fodder

    Tyler,

    You may find that what you are offered is also dependent on the size of the mortgage. People at RedFlagDeals have reported that it requires a certain minimum amount (I think $300,000) to get the bank’s most aggressive rates. Perhaps CU’s operate differently in that the mortgage amount is immaterial.

  19. 25. Ed Rempel

    Hi Ahmet,

    I just noticed your post here. No, your scenario is not correct. In the example in the article, the Parkers set up a 2nd readvanceable mortgage for $120K. They used $20K to pay off debt and $100K to invest. Therefore, the interst on the $100K portion would be tax deductible.

    They would also be able to do a Smith Manoeuvre on this 2nd readvanceable as well, so they could use the principal portion of the mortgage payment on the 2nd to cover the interest on the $100K investment.

    After 4 years, they can roll it into their main mortgage.

    Getting just a HELOC for $120K to invest would provide a tax deduction on all the interest, but they would have to pay from their cash flow both their existing $20K debt and the interest on this $120K HELOC. This is why the 2nd readvanceable with the SM is preferable.

    Ed

  20. 26. Ed Rempel

    Hi Tyler,

    We are generally getting between prime -.65 to -.85% now, depending on various issues. The mortgage market is much more challenging in the last 6 months since the subprime issues. Getting larger discounts from prime takes more effort now. As Cannon mentioned, your credit rating, the size of the mortgage and how much business you have with BMO are all factors, but the main factor is still negotiation. They will still usually match competitors rates.

    We get the better rates for our clients because of a high referral volume, which is why we do Ed’s Mortgage Referral Service.

    Get some good competitie rates and see if BMO will match. If you can’t get a better rate, then email me and we’ll refer you to our BMO contact.

    We have not heard of First Calgary, but they are a credit union and we are not aware of any credit union with a proper readvanceable mortgage. We have become quite skeptical of various mortgage reps making all kinds of claims. Most mortgage reps don’t know how to do the SM, so they don’t know what a good readvanceable mortgage looks like.

    Ed

  21. 27. Jatinder

    To Ed,

    I have just learned about SM, and reading blog(s) here to learn more about it. Yes, I am going to get the book. But my question(s) is(are):
    1. Is this the good time to start SM (looking at the financial situation around).
    2. What is the rate of return we should expect.
    3. Do we “have to” invest in divident funds. Can’t we just get index funds; as this is for long term growth.
    4. What is the minimum HELOC amount we can start with.

    Thanks for any feedback

  22. 28. Ed Rempel

    Hi Jatinder,

    Good questions.

    1. Historically, the best times to invest have been when the markets are low and volatile. The reason that many people have trouble figuring out what to do in today’s volatile markets is because they think too short term. The market is at a historically low level now. Nobody knows whether or not it will go lower or when it will recover, and the truth is that it does not matter much. The markets always recover eventually and studies have shown that investing at points when it is low and volatile have tended to result in considerably higher returns going forward.

    It is obviously difficult to invest in this kind of environment, but when you think about it logically and long term, now may well be the single best time in your entire life to invest.

    2. The rate of return to expect cannot be answered except as a long term expectation. Itr depends completely on how you invest. Short term returns are not predictable any time and vary widely. However, when you get to 10 or 20 years or longer, the expected returns tend to get more predictable. The stock markets have average 10-12%/year long term and higher when you invest at low points. This would of course be lower if you invest partly in bonds or balanced funds.

    3. Regarding your question about dividend funds, let’s be clear about this. The Smith Maneouvre does not involve dividend funds at all. In fact, the “dividend fund” you are referring to is probably really a “return of capital fund”, which results in your investment loan becoming non-deductible. This is a significant tax problem, especially after a few years.

    In almost every case, not using a “dividend” fund is the best advice. They are more risky, since the monthly payment makes it very difficult for the fund to recover from any significant downturn. The long term expected return is usually lower, as well, since few of the best best funds are available as “dividend” funds.

    The best advice in most cases is to invest based on the best risk/return and avoid getting any “dividends”.

    Index funds would be fine. We don’t use them ourselves or with our clients, but they would work fine. We spend our time investigating the world’s best fund managers, which we call “All-star fund managers”. There are fund managers with long term exceptional track records that have beaten their indexes by wide margins over long periods of time, often with less volatility at the same time.

    4. There is no minimum HELOC. The “Plain Jane” Smith Manoeuvre involves reborrowing each mortgage payment to invest, which can start with a HELOC of zero. After your first mortgage payment, you gain equity available in the HELOC from the principal portion, and you can invest that amount.

    Ed

  23. 29. Ed Rempel

    Hi Everyone,

    This environment has made it much more likely to be beneficial to pay the penalty to get out of your current mortgage. We are finding a far higher proportion are worth breaking now than a year ago.

    We are finding quite a few people with high fixed rates where there is a big benefit to break it. Today, we are getting 1.99% to 2.3% on a 1-year fixed, which we believe is the smartest strategy now.

    Also, quite a few people are locking in for 5 years now at prime + 1% or prime plus .8%. These might also be worth breaking, as well. We believe that things will eventually return to normal, which would mean that mortgages with significant discounts below prime will probably become available again, perhaps in a year or 2.

    Therefore, a long term variable that is not prime LESS .5% or more will probably end up being quite expensive as rate normalize. 1-year rates are lower today and will probably still be lower in a few years.

    Ed

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